Investing and taxation can be tricky things, especially if you have been investing for some time. This can get even trickier when you transfer assets to loved ones or contemplate doing so. Taxation hinges on a few fundamental numbers, one of which is the cost basis. Given some interesting changes to the law governing cost basis, you may need to rethink your plans. If you have investment accounts, then you likely are aware of some of the changes that have begun to take effect and will continue to roll out through 2013. One of the most obvious changes was recently addressed in a Morningstar article titled “Beware the Default Method for Cost-Basis Elections.” Are you aware of the difference between the old style of cost basis election and the new possibilities your brokerage firm or mutual fund company can offer? Essentially, the old system of electing a cost basis was typically in the hands of the investor since they had to track and record their own cost basis on various investments. This meant averaging out the cost basis when selling various stocks at tax time. Now the cost basis is directly reported to the IRS from the firm/broker. Companies tend to offer the default means of reporting, but since information is going directly to the IRS, this also means there is enough information for specific-share identification in the cost basis election. The Morningstar article offers some interesting math to support why this actually can be advantageous for the crafty planner. The bottom line is that any trimming you can safely accomplish can secure more favorable capital gains taxation. Why? Because this cost basis carries over into another magic taxation number, the stepped-up basis, when investment assets are transferred. In short, small numerical changes add up and may affect your overall wealth-transfer planning.
Reference: Morningstar (March 26, 2012) “Beware the Default Method for Cost-Basis Elections”